KPMG Sri Lanka’s Suresh Perera and Rifka Ziyard, Tax Principals of KPMG share insights into fixing the country’s tax system and using technology to improve tax administration, and discuss the effectiveness of granting tax concessions to attract investments and the global trends to be cognizant of when drafting a tax reforms agenda.
What elements of Sri Lanka’s tax system do you believe prevent the country from unlocking our true potential for economic growth?
After the first income tax statute, the 1932 Income Tax Ordinance was introduced in Sri Lanka, the tax system in Sri Lanka evolved without a focused methodical development. Taxes have been introduced based on revenue shortage, and have also been re-introduced under different names without any sort of formal plan.
For example, Sri Lanka decided to stop taxing turnover in 1998 because taxing the value addition was more equitable. But a turnover tax was reintroduced in 2009 under the name Nation Building Tax (NBT), meaning VAT and turnover tax were both collected at the same time i.e., a hybrid system. NBT was abolished in 2019 but has returned this time under the name Social Security Contribution Levy (SSCL).
Whilst tax policymaking is devoid of any scientific basis, the ad hoc nature of Sri Lanka’s tax policies makes it difficult for businesses and individuals to plan their cash flows, which significantly affects businesses and their growth.
What are some of the shortcomings you observe in the development of Sri Lanka’s current tax policy?
The influence of the lobby groups on tax policymaking and the absence of a strong and knowledgeable tax unit for policymaking have resulted in a highly inequitable direct-to-indirect tax ratio of 20:80 in our tax system. Indirect taxes such as VAT (Value Added Tax) or turnover tax affect everybody, but being regressive by nature, such taxes take away a greater fraction from the low- or medium-income earners.
Even in 2015, there have been talks of transitioning to a more equitable 60:40 model instead, but that never happened. We are still at 20:80 if not more.
One must evaluate if the Sri Lankan Tax System follows basic concepts of taxation such as equity and convenience. Taxes should be collected according to the ability to pay (broader shoulders to bear more burden).
Collecting taxes need to be convenient as well. We need to consider the perspective of both the taxpayer and the administrator. Although taxes have been introduced over the years, is the collection process efficient and effective? Is there transparency? What have the taxes been used on? The shortcomings in these aspects have made a negative perception of tax collection in Sri Lanka and have led to dissuading taxpayers from voluntary compliance.
What reforms do you believe are needed to improve Sri Lanka’s tax system?
Sri Lanka needs to have an authoritative body on tax. There was a time the Ministry of Finance had a cluster of tax experts, but that no longer exists. An early implementation of the Presidential Commission on Taxation referred to in the recent Budget is a must.
We also have to reform our VAT which is our highest source of tax revenue. Sri Lanka has about approx. 299 VAT exemptions which are not practical. Countries that are the best at this concept of tax have minimal exemptions because the moment the exemptions are introduced in the middle of the value chain, there’s a break in the value chain that leads to a cascading effect. All economic activities should be covered under VAT.
Although it’s usually better to have a single rate for administrative ease, having different VAT rates is more equitable considering Sri Lanka’s economy. We shouldn’t have luxury items taxed at the same rate as essential items. In order to make the VAT in Sri Lanka more equitable, the policymakers should explore the option of multiple VAT rates as opposed to a single rate such as introducing a higher VAT rate of around 20% on luxury items, a standard rate of about 12% and a lower rate of about 5% on essential items. Though it causes an administrative inconvenience, it will make the VAT system equitable.
There is much room for improvement in the monitoring and supervision of tax collection. There is an important role to be played by the investigative officers in the IRD in this regard. This is more of a weakness in the administration than a policy problem.
A long-term reform could include simplifying our tax system. A simpler system will reduce the administrative burden and make it easier for enforcement. We should also rethink our approach towards tax incentives. Everyone should be paying their fair share of taxes and when everyone starts feeling that way, we can create a positive taxpaying culture.
How can we use technology to improve tax administration in Sri Lanka?
A digital Revenue Administration and Management Information System (RAMIS) was introduced by the Tax Department which is a positive step forward. But there are a lot of shortcomings in its execution.
It’s reported that more than Rs 10 billion was spent to create RAMIS, but it’s malfunctioning, and taxpayers faced difficulties in uploading their income tax returns. Filing corporate tax on the system is mandatory, which is a good thing. We shouldn’t abandon the RAMIS, instead, any weaknesses or shortfalls need to be rectified to ensure the system is functional.
It is important that we introduce technology to the tax collection process in handling both direct and indirect taxes.
Currently, many Southeast Asian and South Asian countries have transitioned into real-time invoicing which helps in the prevention of VAT fraud. The added benefit is that you don’t have to wait three or four years to conduct an audit, by which time, the tax administrator and the taxpayer may not be able to locate the relevant documents.
This is a real shortcoming. As a result, we now have a tax administrator who is writing off years of taxes with no effort to recover them from defaulters and tax evaders at a time when the country is desperately in need of that income.
How effective are the current tax incentives in attracting investments?
One of the biggest shortfalls of our system is the fact that we don’t have the research data to be able to evaluate how the country has benefited and how effective the country’s current tax incentives have been.
This includes tax holidays. We’ve been giving them since 1978 and the way we have done so is not the most efficient. Major corporations that can afford to pay taxes are not being taxed as a result. Even considering some of the Strategic Development Projects, we’ve been giving tax holidays for up to 25 years, and sometimes even 40 years.
We are only sacrificing tax revenue by granting tax holidays. Policymakers might believe that giving zero taxes will attract more investors, but there’s more to it than that. Strong infrastructure and certainty in policies are comparatively more attractive to investors. Countries such as Vietnam and Cambodia are attracting more investors because of the certainty in what they do while we offer tax holidays and get less in the end.
We should be attracting investors with strong policies because any investor is willing to pay even a premium in tax if there is transparency and certainty. Singapore doesn’t offer any tax incentives, but they are precise. Singapore recently announced it will be increasing its VAT by 1% in 2024. By announcing it this early, it’s easier for businesses to plan. Any company would want to operate in such an environment.
Ireland is a country considered by some as a tax haven. By lowering their tax rates below other countries, they have attracted revenue streams that wouldn’t have come otherwise. Instead of offering zero taxes, we should be offering comparatively lower taxes than the rest. An investor wouldn’t mind paying a low tax, and the economy will benefit from such tax collections.
What measures can we implement to course-correct?
At this juncture of the economic crisis, tax revenue is vital to the Government, however, the tax revenue should be gathered in an equitable manner taking into consideration the ability to pay.
This is an opportunity for the Corporates that have been granted prolonged tax holidays to contribute on account of infrastructure usage, reducing the tax burden on the shoulders of low-income earning individuals. In the past, companies enjoying tax holidays contributed by way of the Economic Service Charge (ESC) a low percentage of their turnover.
This could be a great way to help navigate the ongoing economic crisis in the short term. A mechanism could be considered where persons with broader shoulders are called upon to contribute to the tax revenue to overcome this economic crisis, and they are granted tax credits/ rebates in the future on account of their higher tax contributions now.
What global tax trends should Sri Lanka be considering?
Sri Lanka is in strong need of a digital tax because the way we do business has changed with the development of technology. Companies outside Sri Lanka can get revenue from doing business in the country using different platforms and trading models. With no proper tax system and laws to tax them, there is no level playing field between foreign digital service providers and local digital service providers/traders.
For example, a person from Sweden can book a hotel and transport in advance when travelling to Sri Lanka using an online platform. That revenue goes through that website to another country, and it is not taxed in Sri Lanka. The government recognized this in 2017 in their budget speech and proposed a tax for such online transactions, but no action was taken thereafter. The worst part is that Sri Lankan companies doing online trading are getting taxed whereas foreign entities are not. Many developed and developing countries have introduced a tax on digitalization.
The Organisation for Economic Co-operation and Development (OECD) recognised the potential for companies to exploit lower tax regimes to maximise profit and have implemented countermeasures. This includes digital taxation based on where the sales take place and allocating the income to that jurisdiction. If the customers are from Sri Lanka, then a proportion of the profits are given to the country to tax.
There is also a proposal to introduce a global minimum tax of 15% for multinational companies with a threshold of over 750 million Euros. For example, if a company is paying a tax rate of 12% in a country, the difference of 3% must be shared with the company’s home country. This is set to be implemented in 2023.
This is also one more reason not to have tax holidays in place because we would simply be losing tax money that could have stayed in Sri Lanka to another country. Around 136 countries have signed up with these propositions. Sri Lanka has not yet but this will still affect us.
We should also make use of the automatic exchange of information under the Common Reporting Standards. This could help Sri Lanka identify anyone who is evading taxes by parking money outside the country through communication between states and sharing information. We should be giving priority to identifying tax evaders now, especially since we are in this crisis. Doing so will also improve the credibility and transparency of our tax system as well.
How does KPMG fit in helping its clients navigate Sri Lanka’s changing economic landscape, especially with its tax system during this turbulent time?
We believe it’s important that our clients are well-informed proactively on what may take place in the economic landscape, and how it might impact them and help them be cost-effective within a legitimate framework.
This includes providing impact assessments – something many Sri Lankan businesses overlook – to understand how the changing situation can impact their cash flow. Our assistance has helped our clients greatly in working towards cost-efficient approaches within the legitimate framework because they have already planned for what might come. Challenging times provide many opportunities as well and KPMG strives to highlight such opportunities to its clients.